“The new bargain” – in conversation with Ros Altmann

This is our chance to speak with the bosses!

This blog is in response to Ros Altmann’s comments on Mark Fawcett’s “new bargain”. It is good that this discussion is happening, though my thoughts are amateur and are driven by opinion rather than a deep understanding of private markets. We need a proper debate about how our retirement savings are managed and this looks like part of it. Ros’ comments are in italics, mine in red.

Dear Henry, thanks for your response to my comments. I certainly do not advocate LDI and bond-yield returns for DC and am referring to the performance of the assets in DB schemes which have benefited from diversification into illiquid and other types of asset class, to benefit from long-term risk premia that should be available for success.

I am pleased you talk about long-term risk premia, from what I hear from those close to private investments, current conditions mean the harvesting of short-term risk premia will yield a meagre crop. This may be a good thing as it reduces the opportunities to trade – which I see as damaging the stability of companies invested in and rarely in the interests of investors.  There have been attempts to replicate LDI structures within DC, they have failed – DC is not ready to be locked down just yet!

The problem with DC investing, relying only on equities and bonds, is that this does not take advantage of the market inefficiencies which exist more frequently in less publicly scrutinized markets.

I agree that the private markets provide opportunities for growth , let’s hope we can avoid strategies which take advantage of vulnerable stocks and profit from their demise. This seems to be against the S in ESG and trustees need to be clear with their managers that they are looking at long-term growth.

Also, with assets like infrastructure, there is both a growth and a real income rationale, which can be tapped into and which DB schemes have used to their advantage. The current DC landscape does not seem to factor in long-term inflation protection directly at all. Even in the annuity space, the emphasis is always on fixed, level annuities (because they are the only way that buying an annuity at a relatively young age (in your 60s!) can look even remotely attractive for those in good health.

Your argument seems to accept that “DC and pensions” can be spoken of together. I agree that large DC schemes should be considering paying inflation proofed pensions and that the emphasis on scheme design needs to turn from lifestyling (where the aim is typically to de-risk) towards an ambition to pay a wage in retirement. Infrastructure supports the payment of “real income” – which I take you to mean – “income that keeps pace with inflation”.  Your points about annuities are well made. Currently, many annuities are set up with the option to be replaced within a couple of years by lifetime annuities, the current annuity market is in a holding pattern awaiting the return of interest.

Having a more diversified approach can help with inflation protection as well as upside returns. DB has become more obsessed with managing downside risks that many schemes have perhaps focussed too little on gaining the upside above liabilities which is essential for paying the pensions after costs.

Is this not a consequence of over-zealous regulation designed to protect the PPF at all costs? Your work in the Lords , with Sharon Bowles did much to convince Government to relax its position on “open DB pensions”, I hope this will be reflected in a softer re-write of TPR’s DB funding code. I have made the point to the Pensions Minister that open DB, CDC and consolidated DC share the capacity to invest for growth.

In the end, though, on the issue of fees, only the largest schemes are likely to have the muscle to negotiate the best fee deals and that is the same in DB. The advantage that DB trustees have is that they are not held to daily pricing or liquidity and can take a longer term view, which is what I believe we need in DC too.

This is part of the new bargain isn’t it? Mark Fawcett’s phrase has implications not just for fees but for people’s expectations from their pensions. So long as pensions are promoted as tax-advantaged wealth then liquidity will be to the fore. This is where the advisory market  and DC pension trustees diverge. The wealthy , especially since Woodford, have a right to be wary of illiquids. They find themselves locked into property funds and “gating” is still a specter hanging over hedge-funds. Right now, trustees are wary about offering illiquids on a stand-alone basis as members may be in the legal position of demanding liquidations under scheme rules.

I have heard legal opinion  that trustees may be liable to create that liquidity – possibly with recourse to the sponsor. Trustees have a right to be nervous.  But large schemes with defaults that allocate a small percentage to illiquids need not have these worries. The Government’s agenda is to bifurcate the market with SIPPs serving the wealth market and large workplace pensions serving the non-advised (and typically less wealthy).

I would not pay 2+20% to any manager because I believe the advantages are too skewed towards the manager. A 2% annual fee in the current interest rate environment seems extraordinary for an institutional portfolio. It has taken many years for DB trustees of the largest funds to negotiate harder on fee levels, the smaller schemes are still paying more. I suspect the same for DC is likely.

I am sure you are right, though Government seems bent on recreating the DC market so that the “new bargain” can happen quickly. I see a lot of people paying 2 and 20 type fees in the wealth market. They are not formally structured that way but if your client is paying 2%pa +  and being hit by exit penalties, the impact is at least as severe.

Of course a lot of this cost is to do with platforms and advice and buys a lot more than fund management, but if organizations like Nest can offer no penalties on entry and exit and funds that include the diversifying strategies you talk of, workplace pensions become an attractive alternative for the wealthy. The FCA continue to push advisers to get their clients to consider workplace pensions as a benchmark, I can understand why advisers are nervous – this kind of competition is good news.

There are no easy answers and QE has distorted conventional risk measures in ways we cannot yet understand, so we do not really know what relative risks in capital markets are. The Capital Asset Pricing Model relies on the underlying risk-free rate being ‘risk-free’, but central banks have interfered with this now, so I would argue there are no risk-free assets and concepts of ‘high risk’ and ‘low risk’ are less reliable than ever before.

This argument is new to me but I can see where you are coming from. Of course much advice is given on the basis of a client’s “risk appetite” and the assumption is that “risk” is measured against cash as a risk-free rate. If you are suggesting  that this assumption needs to be revisited, what do you see the new “risk free rate” as being based on? Do you think that “risk free” is a misnomer? I like Leonard Cohen’s view in his anthem 

“There is a crack in everything, that’s how the light gets in”

Once again, an argument for diversification across assets. But certainly not a case for paying extortionate fees.

I am very happy with your conclusion. I don’t understand why the price to access private markets should be set at such a premium. It is up to those who demand high prices to justify their value and it’s up to those who pay them to exercise their right not to.

The “new bargain” may include concessions on both sides. DC funds cannot demand daily pricing and force liquidity. Private managers must find a way to price their services at rates acceptable to trustees, regulators and the law. This discussion is helpful to me and I hope it is helpful to people who read this blog. If you have comments to make and would like to join in the conversation, please post them. We are all learning and the new bargain is still a long way from being settled.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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